How The Royal Banking Commission Could Burst The Housing Bubble

While I don’t usually speculate on future house prices and what is the Great Australian Housing Bubble, a few things have recently caught my attention. The main discussions mostly relates to the borrowing costs that the four main Australian banks pay.

This has recently gone up slowly over time thanks to a multitude of factors such as the US increasing their interest rates and some new tax laws over there which mean a lot of companies are repatriating their money back into the US.

This means there is a huge outward flow of US cash (internationally speaking), which reduces the international supply and thus, increases its price. This higher price then contributes to making the rate at which big banks borrow money increase.

Along with this we hear the RBA has left rates on hold once again setting themselves up for a new Australian record for leaving rates on hold for the longest time ever. According to analysts, because the costs that the big banks pay to borrow money is increasing they have three options to recover this higher cost.

They can raise home loan interest rates

They can decrease deposit interest rates

They can just cop the difference and have lower profits.

Lower Profits Not Fun

As you can imagine, banks don’t exactly like having their profits eaten away so a lot of people are speculating that they will raise interest rates on mortgages even though the RBA isn’t raising the cash rate.

On top of all this we have the Royal Banking Commission which is putting increasing pressure on the banks in terms of media coverage. This also puts them in a seconddifficult position as not only does it look like they will have to raise interest rates on mortgages outside of a usual cash rate increase, but it also means they will have to do this whilst being under intense media coverage.

Obviously they don’t want to make themselves look even worse than what the Royal Banking Commission has already been doing. For the moment it doesn’t look like the banks are moving though which means they are probably just taking the hit to their profits in order to not look bad and hoping that the cost of their debt doesn’t rise too much more.

Unfortunately that doesn’t look like it will be the case as America increasing their interest rates and the new tax laws over there causing everyone to repatriate their money back into the US aren’t going to change anytime soon.

Threat To The Housing Bubble

To me though the more pressing issue is the Royal Banking Commission which recently made headlines for potentially wanting to change how the banks classify people’s expenses when they calculate how much they’re allowed to borrow.

You can read about it in more detail in the link above but essentially the Royal Banking Commission is saying that the banks assumed expenses for a person when they borrow a loan is way too low and needs to be far higher.

However when you redo the calculations at that high expense level it means everybody cannot borrow as much money as they previously could. One example given was for a person who earns $80,000 a year. While currently they could borrow upwards of $337,985 with the new, “more responsible” lending practices they would only be able to borrow a paltry $195,912!

Now while you might not think this doesn’t sound like too much of a problem – especially if you already have a mortgage – what you need to realise is that almost every time throughout history when credit is severely restricted or restricted in any way for that matter, housing prices go down.

The Credit / Housing Link

If it was just the case of America raising its interest rates and the big banks needing to up mortgage interest rates to reflect these increasing costs, then I wouldn’t think too much of it. I would expect that as the interest rates on home loans rose, house prices would slowly deflate as it becomes less palpable to borrow more money.

But if this Royal Banking Commission pushes through these major changes, we could witness a very severe and very sudden change in how much every person nationwide is able to borrow. If this sudden change is as big as reported, we’re talking about 40% less borrowing capacity.

History is very clear when it comes to house prices and their relation to people’s ability to obtain credit. It’s a simple equation, if no one can borrow money from the banks, no one buys houses and the market tanks. But don’t take my word for it, let’s have a look at one of the most recent credit crunches and what happened to house prices…

As predicted in earlier reports dating from 2006 and 2007, a property price crash hit Ireland by the first half of 2009. It coincided with the 2009 recession as both had started to develop in late 2008 following the global economic slowdown and credit control tightening. By June 2009, it was reported that around 40% of the price escalation that had occurred during the property bubble years (“Celtic Tiger Part 2”) of 2001–2007 had been lost. As of 2012, house prices are below the 2001 prices and more than the entire gain during the Celtic Tiger years has been erased – Wikipedia Ireland Housing Bubble

Or how about the Spanish property bubble that also collapsed due to the restriction in credit or “credit crunch” caused by the GFC. In almost every case not having freely available credit from banks essentially stops housing markets in their tracks. If this change comes in, people that once could consider going off and buying a $500,000 property now wouldn’t be able to even come close to getting that sort of loan.

Not Crashing Just Yet…

While the Royal Banking Commission is still out on its verdict to do this, it struck me as a highly volatile situation. It will be very interesting to watch it play out over the next few months. While I still believe Australia is a fantastic place to live and that our current high house prices are indeed somewhat deserved, they do seem a bit too high.

What is also quite clear is that whether or not it’s through the RBA raising its cash rate or the banks raising them out of cycle, home loan interest rates are looking quite likely to rise in the near to medium term future. This means that the more you can pay off your mortgage now, the better off you’ll be. So get paying off that mortgage!

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